Answer to Question #156910 in Macroeconomics for KJB SONYONI

Question

Explain what is implied with intertemporal substitution.      [4]

2.2 Explain the wealth effect as a reason causing the AD curve to slope negatively.       [4]

2.3 Write notes to effectively contrast the long-run aggregate supply curve and the short-run aggregate supply curve and also elaborate on how both are affected by the price level.[10]

2.4 An interesting result of increasing the tax rate is that it may not always lead to higher tax revenue. Explain this statement.

Answer 1

2.1

Intertemporal substitution is the substitution of the future for present production and consumption or the substitution of the present for future production and consumption.

For example, if an economy consumes a huge proportion of its national income and invests or saves only a small proportion, it will experience a slow economic growth and a smaller consumption in future.

However, if an economy consumes a small amount of it national income and saves or invests a large proportion of its national economy will experience fast economic rate and will have a higher consumption in future.

The trade offs in intertemporal substitution reflect the time preference for consumers for current as opposed to future consumption.

2.2

A fall in price increases the value of wealth meaning the purchasing power increases. For instance, 25%, fall in price level will enable $10,000 of wealth to purchase more goods and services than it would have if the price level had not fallen. An increase in wealth will induce people to increase their consumption. Therefore, at lower price levels the consumption component of aggregate demand will be greater than at higher price levels. The relationship between the price level and wealth is negative hence it yields a negative slope

2.3

The long-run aggregate supply curve is a vertical line at the potential level of output. The intersection of the economy’s aggregate demand and long-run aggregate supply curves determines its equilibrium real GDP and price level in the long run.

The short-run aggregate supply curve is an upward-sloping curve that shows the quantity of total output that will be produced at each price level in the short run. Wage and price stickiness account for the short-run aggregate supply curve’s upward slope.

Changes in prices of factors of production shift the short-run aggregate supply curve. In addition, changes in the capital stock, the stock of natural resources, and the level of technology can also cause the short-run aggregate supply curve to shift.

2.4

more revenue will be earned at 1% than at 0% but at 100% you will eran less revenue than at 10% because of the disincentives caused by high tax rates.